Caledonia Products
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Caledonia Products Company is introducing a new product. With previous fallouts from the company and ranging a 34% marginal tax bracket with a 15% required rate of return or cost of capital the change of direction is to initiate the new plan. Mr. V. Morrison, CEO, Caledonia products is asking for professional guidance to analyze his current cash flow statement to determine if the project of adding two mutually exclusive projects is profitable. Therefore, as an Assistant Financial Analyst, is take into account the interest to calculate Project A and Project B’s payback period, net present value, and internal rate of return to provide a recommendation on which project is tangible than the other.
Payback period
The payback period is the length of time required to break even on an investment measured in years. Where the annual cash flow is identical, the payback period is equal to the investment divided by the annual cash flow. The payback period emphasizes the liquidity of an investment but not its value. Caledonia Products have both projects A and B at an equal negative value of ($100,000) in the first year at an 11% rate of return.
Project
Year
UNDISCOUNTED FREE CASH FLOWS
PVIF * 11%, n
DISCOUNTED FREE CASH FLOWS
CUMULATIVE DISCOUNTED FREE CASH FLOWS
($100,000)
($100,000)
($100,000)
$32,000
$28,832.00
($128,832.00)
$32,000
$25,984.00
($154,816.00)
$32,000
$23,392.00
($178,208.00)
$32,000
$21,088.00
($199,296.00)
$32,000
$18,976.00
($218,272.00)
3 years and 2 months
The payback period for project A occurs in three years and two months to recover the money.
Project
UNDISCOUNTED FREE CASH FLOWS
PVIF * 11%, n
DISCOUNTED FREE CASH FLOWS
CUMULATIVE DISCOUNTED FREE CASH FLOWS
($100,000)
($100,000)
($100,000)
$0.00
($100,000.00)
$0.00
($100,000.00)
$0.00
($100,000.00)
$0.00
($100,000.00)
$200,000
$118,600.00
($218,600.00)
4.5 years
The payback period for project B occurs in four and half years to recover the money.
Net Present Value at an 11% Rate of Return
Year
Project A
Project B
-100,000
-100,000
32,000
32,000
32,000
32,000
32,000
200,000
$11,208
$11,608
Net Present Value (NPV) is the standard method for the financial appraiser of long-term projects. Measuring the excess or shortfalls of cash flows is to measure the difference of the invested and market cost. This method is a good investment, if of course, it brings money to the company, after the discounted rate is calculated. The discounted rate is the project’s Cost of Capital. If the present cash flows and future cash flows are done correctly, this will give the company the New Present Value. Thus, the projects should be accepted only if the plus is on the calculations of Net Present Value NPV > 0 measurements of time, profitability, value to the organization value to the shareholders.
Internal Rate of Return
The internal rate of return used for investments which produces cash flow over time. Internal rate of return is the discount rate that makes the net present value those cash flows equal to zero. The initial outlay for each project was $100,000. Project A’s internal rate of return is 18% while project B’s internal rate of return is 15%. Both projects have significantly higher internal rates of returns compared to the average.
Project Ranking Conflict
The project ranking conflict has three different types of problems when reviewing and comparing two different project proposals, which are a disparity in size of the projects; a disparity in time or an unequal lives problem. If the problems do not rank the same, than the error is usually due to one of these problems and they have to be carefully reviewed and calculated to determine which project is the most efficient project for the company. The ranking problem usually has to be determined first before the decision can be made about which project will be chosen.
With the two mutually exclusive projects that Caldonia Products is trying to choose between seeks only two issues that are causing a ranking conflict, which are the size disparity and the time disparity conflicts. The size disparity